Sunday, February 5, 2012

a.§ 453(a)- Gain from an installment sale
is ordinarily reported on the installed method, which is defined by § 453(c) as “a method under
which the income recognized for any taxable year from a disposition is that
proportion of the payments received in that year which the gross profit… bears
to the total contract price.” Gross profit is the gain realized on the
disposition and the contract price is the amount realized.

b.The
goal is to determine the amount of income recognized for a particular taxable
year:

iv.The idea behind the installment method
is to treat every principal payment as a microsm of the entire transaction.

c.Payment
is the most disputed, what is consideration. Consideration v. Promise to Pay

i.Does not include a buyers promise to pay.
What about third parties? Include a third party obligation as part of payment.
Include it as fair market value.

ii.EXCEPTIONS:

1.Readily
tradable- If it is
liquid and there is an established market, include it as payment received even
if it is a debt instrument

2.Also, if it is secured by cash or a cash equivalent

iii.These are all rules about principal
payments. The tax consequences of interests are different. You must allocate
basis among the assets with more complicated payments.

d.CONTINGENT INSTALLMENT SALES:

i.There
are also big issues with contingent sales in this area of the law. For example,
a percentage of profits the seller is entitled too.

ii.If we don't know the whole contract
price, can’t calculate gross profit. However, congress is clear that in § 453 (j)(2)they wanted them to
have installment treatment,
regulations about how the installment can work when you don't know the full
contract price.

1.Transaction
in which there is a maximum possible price

a.Treat
the maximum as the contract price, if you get less, you re-compute the formula
and take a loss deduction for the amount you overpaid.

b.You
can make a deduction if you over paid. TAX
BENEFIT RULE

2.Transaction
in which there is no max price, but the period of time over which the payments
will come in is known.

a.Pro-rate
the taxpayers basis over the known period of years in the contract.

b.Then
subtract the gain from the basis

3.Transactions
in which we don't know either of the first two things. No max selling price or
max time period

a.IRS
might think that it is not a real sale contract. Disguised interest payments,
royalties, or rent. Convince the IRS that it is a sale. The IRS will look
skeptically upon this.

b.If
they scrutinize all the pertinent facts, they will pretend that the contract is
15 years long and pro-rate the basis over that period of time. You can argue
with the IRS over this Then
there can be an offset.

e.INTEREST
PAYMENTS received will
be included in the gross income of the seller as ordinary income under§
61(a)(4), and interest paid may be deductible by the buyer under § 163

f.What
about payments that trickle in over time
that were not in the original sales contract. Does this apply to involuntary
installment sales? There is policy reasons for allowing unintended sales to
allow this:

i.Taxpayers don’t pay realize any gain

ii.Liquidity problem, might not have enough
money to pay the tax on the entire amount.

g.Amended Agreements: Not clear in § 453 if the buyer agrees to pay in full, and then in
amendment is allowed to make some of the payments late. If the amendment is
made before the sale closes, then the installment rules should apply.There
was never a contractual right to have the money from the sale, then the
installment sale rules can apply.

i.The installment sale rules don't apply
if the parties amend the contract after the seller has fully performed and has
an unconditional right to payment. NOT INSTALLMENT SALE

ii.Doctrine
of constructive receipt. Congress does not allow people to avoid tax by turning
their back on payments.

h.There
is a lot of fighting over this because Congress has a choice how to tax
installment sales, they could have completed them as complete for tax purposes
in the first year of the installment sale. However, they thought that was to
harsh and allow people to recognize payments gradually.

i.Limits
on Installment Method

i.You can't do it for stocks on securities
market

ii.Cant do it from dealers on property

iii.No inventory

iv.Not for sales of depreciable property to
affiliated entities.

j.Installment
Method is elective and can be used in connection with § 1031. Remember that
1031 like kind exchanges are not elective though and you must conduct the
transaction in that manner if you qualify.